Review of Network Economics Vol.

2, Issue 3 September 2003

191
Some Empirical Aspects of Multi-sided Platform Industries
DAVID S. EVANS*
NERA Economic Consulting
Abstract
Multi-sided platform markets have two or more different groups of customers that businesses have to get
and keep on board to succeed. These industries range from dating clubs (men and women), to video game
consoles (game developers and users), to payment cards (cardholders and merchants), to operating system
software (application developers and users). They include some of the most important industries in the
economy. A survey of businesses in these industries shows that multi-sided platform businesses devise
entry strategies to get multiple sides of the market on board and devise pricing, product, and other
competitive strategies to keep multiple customer groups on a common platform that internalizes
externalities across members of these groups.
1 Introduction
Multi-sided platforms coordinate the demand of distinct groups of customers who need each
other in some way. Dating clubs, for example, enable men and women to meet each other;
yellow pages provide a way for buyers and sellers to find each other; and computer operating
system vendors provide software that applications users, applications developers, and hardware
providers can use together. When devising pricing and investment strategies, multi-sided
platforms must account for interactions between the demands of multiple groups of customers. In
theory, the optimal price to customers on one side of the platform is not based on a markup
formula such as that given by the Lerner condition, and price does not track marginal cost.
Competition among platforms takes place when seemingly distinct customer groups are
connected through interdependent demand and a platform that, acting as an intermediary,
internalizes the resulting indirect network externalities (Rochet and Tirole, 2003). Platforms are
central to many key industries including computer games, information technology, many
internet-based industries, media, mobile telephony and other telecommunications industries, and
payment systems.

* David S. Evans. Senior Vice President. NERA Economic Consulting, 1 Main Street, Cambridge, MA, 02142.
Email: David.Evans@NERA.com The author is extremely grateful to Howard Chang, Richard Bergin, Lauri
Mancinelli, John Scalf, Nese Nasif, and Bernard Reddy for their many contributions to the research upon which
article is based. This paper draws material from The Antitrust Economics of Two-Sided Markets available at
http://aei.brookings.org/admin/pdffiles/phpMt.pdf.
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This article provides an empirical survey of entry, pricing and other strategies in platform
industries. It provides background for the emerging theoretical (Rochet and Tirole, 2003; Julien,
2001; Armstrong, 2002; and Parker and Van Alstyne, 2002); empirical (Rysman, 2002), and
policy (Evans, 2003) literature on multi-sided platform markets. Although it does not provide
empirical tests of either the key assumptions of this literature or its implications, it confirms that
multi-sided platforms are an important, and until recently unrecognized, part of the industrial
organization landscape, and that this new area of economic research has potentially rich
empirical implications and relevance. This article is based, and reports early results, of a series of
detailed case studies of multi-sided platform industries I have been conducting.
Section 2 summarizes the conditions under which a multi-sided platform may emerge and the
main theoretical findings of the literature to date. It also provides a brief overview of the three
major kinds of platforms. Section 3 reviews some common business practices followed in multi-
sided platform industries studied thus far. I then turn to two more detailed case studies. Section 4
reviews the entry of Diners Club in the payment card industry and summarizes the pricing
strategies that continue to this day. Section 5 examines the entry of the Palm operating system
for personal digital assistants. Section 6 makes some brief concluding remarks.
2 A brief review of the economics of multi-sided platform markets
There is an opportunity for a platform to increase social surplus when three necessary conditions
are true: (1) there are distinct groups of customers; (2) a member of one group benefits from
having his demand coordinated with one or more members of another group; and (3) an
intermediary can facilitate that coordination more efficiently than bi-lateral relationships
between the members of the group.
1
As an empirical matter, indirect network effects generally
accompany condition (2) and intimately shape the business strategies in these industries along
side the multi-sidedness.
(1) There are two or more distinct groups of customers. These customers may be quite different
from each other, such as the men and women for a dating platform or retailers and
customers for a shopping mall. Alternatively, these customers may be different only for the
purpose of the transaction at hand eBay users are sometimes buyers, sometimes sellers;
mobile phone users are sometimes callers, sometimes receivers.
(2) There are externalities associated with customers A and B becoming connected or
coordinated in some fashion. A cardholder benefits when a merchant takes his card for
payment; a merchant benefits when a cardholder has a form of payment he takes. The
presence of indirect network effects seems to be an empirically important explanation for
the emergence of a platform although not necessary as a matter of theory. Sellers of PEZ
dispensers value exchanges that have more people who would like to buy PEZ dispensers.
(See discussion of eBay below.)
(3) An intermediary can internalize the externalities created by one group for the other group.
Obviously, if the members of group A and group B could enter into bilateral transactions

1
See Rochet and Tirole (2002), Rochet and Tirole (2003), Rochet (2003), Armstrong (2002), and Parker and Van
Alstyne (2002).
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they would be able to internalize the indirect externalities under the second condition (2).
However, in practice information and transaction costs and free-riding problems make it
difficult for members of distinct customer groups to internalize the externalities on their
own.
2
You can look for your new sweetheart by strolling around the Boston Public Garden;
the Yahoo! Personals are less romantic but perhaps more efficient. The intermediary does
not have to be a business in the usual sense. Cooperatives have emerged in payment cards
(Visa International) and software (Linux). Governments sometimes act as the intermediary
currency is an example.
Several articles have examined the economics of price determination in multi-sided platform
markets. A key finding is that optimal prices for the multiple customer groups must align or
balance the demand among these groups and indeed the emergence of a pricing structure as
well as a pricing level is the defining characteristic of such industries (Rochet and Tirole, 2002).
Optimal prices are not proportional to marginal costs as is the case with the familiar Lerner
conditions
3
or its multi-product variants.
4
Indeed, it is possible that the optimal price for one side
will be less than the marginal cost for that side (Parker and Van Alstyne, 2002). (The assignment
of costs to one side or another may not be well defined either. When it is necessary to get both
sides together for a platform product to exist that is for either customer to have anything to
purchase one may not be able to say that one side or another caused a cost.) Platform
businesses may tend to skew prices towards one side or another depending upon the magnitude
of the indirect network externalities resulting from that side. If side A generates a much greater
degree of externalities for side B than side B does for side A, side A may tend to get a lower
price (Parker and Van Alstyne, 2002). As in Ramsey-type models of multi-product pricing, in
which firms are pricing in part to recover common costs of production, one side may end up
contributing more to common costs than another side. However, the economic reasons for this
are different in multi-sided than in single-sided markets.
5
Note that the theoretical literature is
based on quite rarefied assumptions and has thus far focused on static pricing issues.
The remainder of this article examines several multi-sided platform industries. It is helpful to
divide multi-sided platforms into three categories: (1) market-makers; (2) audience-makers; and
(3) demand coordinators. Table 1 provides further examples of multi-sided platform markets and
businesses that participate in these markets. While by no means exhaustive, it illustrates the
variety of multi-sided platform industries.
Market-makers enable members of distinct groups to transact with each other. Each member
of a group values the service more highly if there are more members of the other group
because that increases the likelihood of a match and reduces the time it takes to find an
acceptable match. Examples include exchanges such as NASDAQ and eBay, shopping malls
such as those that dot the New Jersey Turnpike, and dating services such as Yahoo! Personals.
6


2
In unpublished work Jean Tirole points out that a necessary condition for multi-sided platforms to arise is that the
Coase Theorem does not apply.
3
The Lerner condition was first stated in Lerner (1934).
4
See generally Baumol, Panzar and Willig (1982).
5
See generally Rochet and Tirole (2003), and Parker and Van Alstyne (2002).
6
See NASDAQ (2003) Market Characteristics http://www.nasdaq.com/about/market_characteristics.pdf, eBay
Inc. (2003) Company Overview, http://pages.ebay.com/community/aboutebay/overview/index.html, Pashigian
and Gould (1998), and Yahoo! Inc. (2003) Yahoo! Personals, http://personals.yahoo.com/.
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Industry Two-Sided Platform Category Side One Side Two
Side that Gets
Charged Least Sources of Revenue
Real Estate Residential
Property Brokerage
Market-
makers
Buyer Seller Side One Real estate brokers derive income principally
from sales commissions.
a

Real Estate Apartment
Brokerage
Market-
makers
Renter Owner/
Landlord
Typically Side One Apartment consultants and locater services
generally receive all of their revenue from the
apartment lessors once they have successfully
found tenants for the landlord.
b

Media Newspapers and
Magazines
Audience
makers
Reader Advertiser Side One Approximately 80 percent of newspaper revenue
comes from advertisers.
c

Media Network Television Audience
makers
Viewer Advertiser Side One For example, the FOX television network earns
its revenues primarily from advertisers.
d

Media Portals and Web
Pages
Audience
makers
Web
Surfer
Advertiser Side One For example, Yahoo! earns 75 percent of its
revenues from advertising.
e

Software Operating System Demand
coordinators
Applicatio
n User
Application
Developer
Side Two For example, Microsoft earns at least 67 percent
of its revenues from licensing packaged
software to end-users.
f

Software Video Game
Console
Demand
coordinators
Game
Player
Game
Developer
Neither Both sides
are significant
sources of platform
revenue
Both game sales to end users and licensing to
third party developers are significant sources of
revenue for console manufacturers. Console
manufacturers have sold their video game
consoles near or below marginal cost (not taking
into account research and development).
Microsoft, for instance, is selling its Xbox for at
least $125 below marginal cost.
g

Payment
Card System
Credit Card Demand
coordinators
Cardholder Merchant Side One For example, in 2001, American Express earned
82 percent of its revenues from merchants,
excluding finance charge revenue.
h

Table 1: Sources of revenue in selected two-sided platforms
Notes:
a
See Bureau of Labor Statistics, U.S. Department of Labor (2003) Real Estate Brokers and Sales Agents, in Occupational Outlook Handbook, 2002-03 Edition,
362-364, http://www.bls.gov/oco/ocos120.htm.
b
See Ronan (1998).
c
See George and Waldfogel (2000).
d
See FOX (2000) Annual Report.
e
See Yahoo! Inc. (2001)
Annual Report.
f
See IDC (1994) 1994 Worldwide Software Review and Forecast, Report #9358, November, IDC (1995) 1995 Worldwide Software Review and
Forecast, Report # 10460, November, IDC (1996) 1996 Worldwide Software Review and Forecast, Report #12408, November, IDC (1997) 1997 Worldwide Software
Review and Forecast, Report #14327, October, IDC (1999) 1999 Worldwide Software Review and Forecast, Report #20161, October, IDC (2001) Worldwide Software
Market Forecast Summary, 2001-2005, Report #25569, September.
g
See Becker (2000), Fahey (2002).
h
See American Express Company (2001) Annual Report,
http://www.onlineproxy.com/amex/2002/ar/pdf/axp_ar_2001.pdf.

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Audience-makers match advertisers to audiences. Advertisers value the service more if there
are more members of an audience who will react positively to their messages; audiences value
the service more if there are more useful messages (Goettler, 1999). Advertising-supported
media such as magazines, newspapers, free television, yellow pages, and many Internet portals
are audience makers.
7

Demand-coordinators make goods and services that generate indirect network effects across
two or more groups. They are a residual category but economically the most interesting and the
least studied. These platforms do not strictly sell transactions like a market maker or
messages like an audience-maker. Software platforms such as Windows and the Palm OS,
payment systems such as debit cards, and mobile telephones are examples (Rochet and Tirole,
2003).
8

3 Business models in multi-sided platform markets
Several issues occur repeatedly in multi-sided platform markets: getting both sides on board;
balancing interests; multihoming; scaling and liquidity.
3.1 Getting both sides on board
An important characteristic of two-sided markets is that the demand on each side tends to vanish
if there is no demand on the other regardless of what the price is. There are many references in
the literature on the firms discussed earlier about solving the chicken-and-egg problem (Gawer
and Cusumano, 2002). For example, there would be no demand by households for payment cards
if they could not use them anywhere and no demand by retailers for payment cards if no one had
them. Which comes first the cardholder or the retailer (Evans and Schmalensee, 1999)? Men
will not go to dating clubs that women do not attend because they cannot get a date. Merchants
will not take a payment card if no customer carries it because no transaction will materialize.
Computer users will not use an operating system that does not have applications they need to
run. Sellers of corporate bonds will not use a trading mechanism that does not have any buyers.
In all these cases, the businesses that participate in these industries have to figure out ways to get
both sides on board. Investment and pricing strategies are keys to getting both sides on board.
One way to do this is to obtain a critical mass of users on one side of the market by giving
them the service for free or even paying them to take it. Especially at the entry phase of firms in
multi-sided markets, it is not surprising to see precisely this strategy. Diners Club gave its charge
card away to cardholders at first there was no annual fee and users got the benefit of the float.
Netscape gave away its browser to most users to get a critical mass on the computer user side of
the market; after Microsoft started giving away its browser to all users, Netscape followed suit

7
In a fundamental sense, what advertisers demand, and what the various advertising media outlets supply, are units
of audience for advertising messages. Thus advertiser demand for space in the print media and time in the broadcast
media is a derived demand stemming from a demand for audience, and is a positive function of the size and quality
of audience (Ferguson, 1983).
8
Mobile telephone services are not a one-sided market because most users both make and receive calls. A high
termination charge raises the marginal cost of calls and lowers the marginal cost of call receptions. For a given call,
end users are on a single side and their consumption behaviors depend on their own price (calling price for the caller
and receiving price for the receiver). As a consequence, the choice of termination charge is not neutral. See Jeon, et
al. (2001) for more detail.
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(Wong, 1998). Microsoft is reportedly subsidizing the sales of its Xbox hardware to consumers
to get them on board (Becker, 2002). For monopoly and duopoly cases, if there is sufficient
difference in the valuation of a transaction then the market with low valuation will be flooded in
equilibrium and that type will pay zero price according to some recent theoretical work (Schiff,
2003).
Another way to solve the chicken-and-egg problem is to invest in one side of the market to
lower the costs to consumers on that side of participating in the market. Microsoft provides a
good example of this. As we saw earlier, it invests in applications writers by developing tools
that help them write applications and providing other assistance that makes it easier for
developers to write applications using Microsoft operating systems. To take another example,
bond dealers take positions in their personal accounts for certain bonds they trade. They do this
when the bond is thinly traded and the long time delays between buys and sells would hinder the
markets pricing and/or liquidity. By investing in this manner, two-sided intermediaries are able
to cultivate (or even initially supply) one side, or both sides, of their market in order to boost the
overall success of the platform.
Providing low prices or transfers to one side of the market helps the platform solve the
chicken-and-egg problem by encouraging the benefited groups participation which in turn,
due to network effects, encourages the non-benefited groups participation. Bernard Caillaud and
Bruno Jullien (2001) refer to this strategy as divide-and-conquer. Another effect of providing
benefits to one side is that this assistance can discourage use of competing two-sided firms. For
example, when Palm provides free tools and support to PDA applications software developers, it
encourages those developers to write programs that work on the Palm OS platform, but it also
induces those developers to spend less time writing programs for other operating systems (See
discussion of Palm below.)
3.2 Pricing strategies and balancing interests
Firms in mature multi-sided markets i.e. those that have already gone through the entry phase
in which the focus is on solving the chicken-and-egg problem still have to devise and maintain
an optimal pricing structure. In most observed multi-sided markets, companies seem to settle on
pricing structures that are heavily skewed towards one side of the market in the sense that the
margin (price less marginal cost as a percent of price) is far less on one side than the other. Table
1 summarizes the pricing structure for some multi-sided markets. For example, in 2001,
excluding finance charge revenue American Express earned 82 percent of its revenues from
merchants.
9
Microsoft earns the preponderance of its revenue from Windows from licensing
Windows to computer manufacturers or end-users.
10
Real estate brokers (for sales as opposed to

9
If finance charge revenues are included, American Express earned 62 percent of its revenues from merchants in
2001 (American Express Company (2001) Annual Report,
http://www.onlineproxy.com/amex/2002/ar/pdf/axp_ar_2001.pdf.).
10
From 1988 through 2000, Microsoft earned at least 67 percent of its revenues from licensing packaged software
(such as Windows and Office) to end-users (either directly at retail or through manufacturer pre-installation on
PCs). See IDC (1994) 1994 Worldwide Software Review and Forecast, Report #9358, November, IDC (1995) 1995
Worldwide Software Review and Forecast, Report # 10460, November, IDC (1996) 1996 Worldwide Software
Review and Forecast, Report #12408, November, IDC (1997) 1997 Worldwide Software Review and Forecast,
Report #14327, October, IDC (1999) 1999 Worldwide Software Review and Forecast, Report #20161, October, IDC
(2001) Worldwide Software Market Forecast Summary, 2001-2005, Report #25569, September. Note that the 67
percent figure underestimates the amount of revenue Microsoft earns from end-users because the other third of
revenue coming from "Applications Development and Deployment" includes some end-user revenues as well. For
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rent) usually earn most or all of their revenues from the sellers. Political tensions can also
manifest themselves looking out for their narrow interests, customers on each side of the
market would like the other side to pay more. This is a familiar problem in the payment-card
industry in Europe a retailers association asked the European Commission to force the card
associations to eliminate the interchange fee and this tension was behind the retailer litigation
that was recently settled in the United States.
11

Discerning the optimal pricing structure is one of the challenges of competing in a multi-
sided market. Sometimes all the platforms converge on the same pricing strategy. Microsoft,
Apple, IBM, Palm and other operating system companies could have charged higher fees to
applications developers and lower fees to end-users. They all discovered that it made sense to
charge developers relatively modest fees for developer kits and, especially in the case of
Microsoft, to give a lot away for free. Nevertheless, Microsoft is known for putting far more
effort into the developer side of the business than the other operating system companies (Gawer
and Cusumano, 2002).
The debit card is an example in which different platforms made different pricing choices. In
the late 1980s, the ATM networks had a base of cardholders who used their cards to withdraw
cash or obtain other services at ATMs. They had no merchants that took these cards. To add
debit services to existing ATM cards, the ATM networks charged a small interchange fee than
the card associations charged (8 cents per transaction on a typical $30 transaction compared) to
encourage merchants to install PIN pads that could read the ATM cards that cardholders already
had and accept the pins they used to access the ATM machines (Evans and Schmalensee, 1999).
Many merchants invested in the PIN pads the number of PIN pads increased from 53,000 in
1990 to about 3.6 million in 2001.
12
The credit-card associations had a base of merchants who
took their cards but it did not have cards that, like the ATM cards, accessed consumers checking
accounts. The credit-card systems imposed a much higher interchange fee than the ATM
networks, about 37 cents versus 8 cents on a typical $30 transaction.
13
They did this to persuade
banks to issue debit cards and cardholders to take these cards.
14
The number of Visa debit cards
in circulation increased from 7.6 million in 1990 to about 117 million in 2001.
15

Two other factors influence the pricing structure. There may be certain customers on one
side of the market Rochet and Tirole refer to them as marquee buyers that are extremely
valuable to customers on the other side of the market. The existence of marquee buyers tends to
reduce the price to all buyers and increases it to sellers. A similar phenomenon occurs when
certain customers are extremely loyal to the two-sided firm perhaps because of long-term
contracts or sunk-cost investments. For example, American Express has been able to charge a
relatively high merchant discount as compared to other card brands, especially for their corporate

example, database products used by business IT departments are included in the Applications Development
category.
11
See British Retail Consortium (2002) Retail Disappointment as Visa Exempted from EU Competition Rules,
Press Release, July 25, http://www.brc.org.uk/Archive.asp, Guerrera (2002), MacKintosh (2001), and Pacelle,
Sapsford and Scannell (2003).
12
See Evans and Schmalensee (1999) and The Nilson Report (2002) No. 759, March.
13
The ATM systems typically charged a flat interchange fee per transaction, while the interchange fee set by Visa
and MasterCard varied with the size of the transaction. The reported interchange fee comparison is from 1998,
around the time of substantial growth in debit for the ATM and credit-card systems (Evans and Schmalensee, 1999).
14
Visa attracted consumers through an effective advertising campaign and attracted issuers through heavy
investment in a debit processing facility, among other strategies (Evans and Schmalensee, 1999).
15
See The Nilson Report (2002) No. 760, March and The Nilson Report (1991) No. 500, May.
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198
card, because merchants viewed the American Express business clientele as extremely attractive.
Corporate expense clients were marquee customers that allowed American Express to raise its
prices to the other side of the market, merchants. In contrast, when the ATM systems entered
into debit, they had captive cardholders ATM cards could be used for debit transactions, so
consumers did not need to be courted to accept the new payment form. Therefore, it has been the
merchants who must purchase and install expensive machinery in order to process online debit
transactions who have been courted, as we saw above.
3.3 Types of platform market structures
Several different multi-sided market organizations appear in practice. (1) Coincident platforms:
several multi-sided platforms offer substitutable products or services on the same sides. That is
the case in video games, operating systems, and payment cards. (2) Intersecting platforms:
several n-sided platforms offer products or services that are substitutable on less than n sides.
Browsers were sides of operating system and internet portal businesses. ATM networks do not
support credit cards or other cards that are not linked to the depository institution while credit
card systems do not really offer ATM cards. (3) Monopoly platforms that have no competition
on any side. Although this could exist in theory, of course, it is hard to identify any industry for
which this has been true (yellow pages was an example for a time perhaps in some places).
Another aspect of platform competition concerns the extent to which users rely
contemporaneously on more than one platform for a side. Users may be dedicated to one
platform because it is not efficient or otherwise beneficial to use more than one network. For
example, most users do not want to use more than one operating system on their personal digital
assistant. Users may also find that it is beneficial and efficient to use several competing
platforms that situation has been called multihoming. Most merchants accept payment cards
from several competing card systems.
Platform industries often have multihoming on at least one side. Table 2 presents a
summary. Consider, for example, personal computers. One could consider the two sides as
consisting of personal computer end-users and developers of applications. The end-users do not
multihome. They almost always use a single operating system and by far the preponderance of
them use a Microsoft operating system.
16
The developers do multihome. According to Josh
Lerner, in 2000, 68 percent of software firms developed software for Windows operating
systems, 19 percent for Apple computers operating systems, 48 percent for Unix operating
systems including Linux, and 36 percent and 34 percent for proprietary non-Unix operating
systems that run on minicomputers and proprietary operating systems that run on mainframes
respectively.
17
In fact, in recent years the percentage of software firms developing for non-
Microsoft operating systems has increased. The fastest-growing category has been software
firms developing for Unix operating systems including Linux. The percentage of developers in
this category increased from 29 percent in 1998 to 48 percent in 2000.
18

Multihoming and intersecting platforms affect both the price level and the pricing structure.
Theory and empirics are not far enough advanced to say much more.

16
IDC (2001) Worldwide Software Market Forecast Summary, 2001-2005, Report #25569, September.
17
The percentages total to 205, indicating substantial multihoming on the part of developers. See Lerner (2002) and
Corporate Technology Directory (1990-2000).
18
See Lerner (2002) and Corporate Technology Directory (1990-2000).
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Two-Sided Platform Side One Presence of Multihoming for Side One Side Two Presence of Multihoming for Side Two
Residential Property
Brokerage
Buyer Uncommon: Multihoming may be unnecessary, since an MLS allows
buyers to see property listed by all member agencies.
a

Seller Uncommon: Multihoming may be unnecessary, since an
MLS allows the listed property to be seen by all member
agencies customers.
a

Securities Brokerage Buyer Common: The average securities brokerage client has accounts at
three firms.
b
Note that clients can be either or both buyers or sellers.
Seller Common: The average securities brokerage client has
accounts at three firms.
b
As mentioned, clients can be either
or both buyers or sellers.
Business-2-Business Buyer Varies: For example, multihoming may be unnecessary for some
online B2B sites, since buyers can go directly to the B2B platform
instead of contacting multiple individual suppliers.
c
Seller Varies: Multihoming may be unnecessary since the B2B
can inexpensively reach a large audience.
d

Peer-2-Peer Buyer Varies: Multihoming may be unnecessary for buyers using online
auction sites since eBay holds 85% of the market share (i.e. it seems
that most people purchase their online auction products at eBay).
Alternatively, multihoming may be more common for online dating
services where there are many sites and a large audience of online
singles (considered to be available singles, as opposed to buyers).
e

Seller Varies Multihoming may be unnecessary for sellers using
online auction sites since eBay holds 85% of the market
share (i.e. it seems that most people auction their products
at eBay). Alternatively, multihoming may be more common
for online dating services where there are many sites and a
large audience of online singles (considered to be available
singles, as opposed to sellers).
e

Newspapers and
Magazines
Reader Common: In 1996, the average number of magazines issues read per
person per month was 12.3.
f

Advertiser Common: For example, Sprint advertised in the New York
Times, Wall Street Journal, and Chicago Tribune, among
many other newspapers, on Aug. 20, 2002.
g

Network Television Viewer Common: For example, Boston, Chicago, Los Angeles, and Houston,
among other major metropolitan areas, have access to at least four
main network television channels: ABC, CBS, FOX, and NBC.
h

Advertiser Common: For example, Sprint places television
advertisements on ABC, CBS, FOX, and NBC.
i

Operating System Application
User
Uncommon: Individuals typically use only one operating system.
j
Application
Developer
Common: As noted earlier, the number of developers that
develop for various operating systems indicates that
developers engage significant multihoming.
k

Video Game Console Game
Player
Varies: The average household (that owns at least one console) owns
1.4 consoles.
l

Game
Developer
Common: For example, Electronic Arts, a game developer,
develops for Nintendos GameCube, Microsofts Xbox, and
Sonys Playstation 2, among other consoles.
m

Payment Card Cardholder Common: Most American Express cardholders also carry at least one
Visa or MasterCard.
n

Merchant Common: American Express cardholders can use Visa and
MasterCard at almost all places that take American
Express.
n

Table 2: The presence of multihoming in selected two-sided platforms
Notes:
a
See Frew and Jud (1987);
b
See Scherreik (2002);
c
See Lucking-Reilly and Spulber (2001);
d
See Federal Trade Commission Staff (2000) Entering the 21st Century:
Competition Policy in the World of B2B Electronic Marketplaces: Efficiencies of B2B Electronic Marketplaces, October, http://www.ftc.gov/os/2000/10/index.htm#26;
e
See Cisneros (2000) and Festa (1996);
f
See FCB (1998) Magazines in the Information Age, Media Research Report, Spring,
http://www.magazine.org/resources/research/fcb_magazines_infoage.html;
g
See New York Times (2002), Wall Street Journal (2002), and Chicago Tribune (2002);
h
See
ABC (2002) Local Stations, http://abc.abcnews.go.com/site/localstations.html., CBS (2002) CBS Info, http://www.cbs.com/info/hdtv/., FOX (2002) Fox Affiliates,
http://www.fox.com/links/affiliates.htm., and NBC (2002) Local Stations, http://www.nbc.com/nbc/header/Local_Stations/;
i
See Fisher (1997);
j
See Hacker (2001);
k
See
Lerner (2002) and Corporate Technology Directory (1990-2000);
l
See Yankee Group (2001) Video-Game Penetration Grows to 36 Million Households in 2001, Reuters
News, November 19, http://about.reuters.com/newsreleases/art_19-11-2001_id785.asp;
m
See Game Makers Hedge Bets in Console Wars (2001) USA Today, November
16, http://www.usatoday.com/life/cyber/tech/review/games/2001/11/19/game-makers.htm;
n
See Evans and Schmalensee (1999).
Review of Network Economics Vol.2, Issue 3 September 2003
200
3.4 Scaling and liquidity
Successful multi-sided firms such as Microsoft, eBay, Yahoo!, and Diners Club, have taken
time to test and tweak their platforms to build liquidity before making major investments.
These firms established presence in small markets first, and used trial and error to identify the
correct technology and operations infrastructure in which to invest. Many successful multi-
sided firms seem to adopt a fairly gradual entry strategy in which they scale up their platform
over time. Though much of the network economics literature may suggest that the multi-
sided firm should rely on the right initial investments to help build liquidity over time, it is
often difficult to predict just what the right technology and operations infrastructure will be.
Therefore, successful multi-sided firm seem to found it advantageous to establish efficient
buy-seller transactions first, and make large investments only after the platform has been
tested. For instance, eBay expanded outside the collectibles market only when users started
listing such items up for sale. Figure 1 below outlines the growth of eBays sales categories.
It shows the gross merchandise sales per category in the third quarter of 2002 broken down
by category. The three categories collectibles, early practicals, and practicals are grouped
by the year they debuted.
Category Q3-02 (millions) Yr/Yr
Collectibles:
Collectibles $920 11% Debuted First ~ 1995
Coins & Stamps $400 51%
Early Practicals:
Computers $1,600 44% Debuted Second ~1997
Consumer Electronics $1,400 78%
Books, Movies, Music $1,200 44%
Sports $1,000 35%
Practicals:
Motors $3,800 116% Debuted Third ~ 1999
Clothing $700 98%
Home & Garden $470 90%
Figure 1: eBays category growth
19

Palm also did not invest large amounts into developer support until it achieved sufficient
liquidity on the user side of the market. While small investments were made in releasing a
software development kit (SDK) with the Palm Pilot and making the Palm OS and
architecture accessible to outside developers, Palm made few efforts to sign up key
development partners or to support the Palm development community through classes,
conferences, and other community support activities until a critical mass of users was
assembled in 1998. (See discussion of Palm below.)
Many successful multi-sided firms have tested and modified their platforms with minimal
investment and then scaled up according to what works best. An example comes from
Yahoo!, a firm that has, over time, experimented with providing pages geared to different
audiences such as Yahoo!Personals, Yahoo!Finance, and Yahoo!Travel. In 1996, Yahoo!
developed Yahooligans!, a directory site that linked to content that appealed to children.
20

Yahoo! invested only one programmer and one business developer in their early efforts on

19
See eBay Inc. (2001) Annual Report.
20
See http://www.yahooligans.com.
Review of Network Economics Vol.2, Issue 3 September 2003
201
Yahooligans!, both working half time for three months before the launch. As it turned out,
the bandwidth available to most children at the time 28 kbps was too slow to allow for
content that kept kids attention. Yahooligans! was a relative failure among Yahoo! pages at
the time, but that failure came at a minimal loss to Yahoo! (Bergin, 1998).
A final observation on business models. Contrary to the traditional economic theory of
network effects (Arthur, 1989) and the business advice based on that theory (Shapiro and
Varian, 1999), there is no evidence that building up market share quickly is a recipe for
market domination in platform industries most, if not all of which, are precisely those
industries that economists have cited as having strong network effects. Many of the early
entrants in these industries ultimately did not retain the leadership position: Diners Club in
cards, Apple in personal computer, Apple in hand-held devices, and OnSale in on-line
exchanges. Also, as noted above, despite network effects many platform industries have
several overlapping competing platforms and most have multi-homing on at least one side.
4 Diners Club and pricing in the payment card industry
Frank McNamara, the president of a New York credit company, was having lunch in
Manhattan in 1949. A year later he had a thriving business based on this experience.
According to Newsweek:
21

Halfway through his coffee, McNamara made a familiar, embarrassing discovery; he had left his
wallet at home. By the time his wife arrived and the tab had been settled, McNamara was deep in
thought. Result: the Diners Club, one of the fastest-growing service organizations.
McNamara and an associate, Ralph Schneider, started small. Beginning with less than $1.6
million (in 2002 dollars)
22
of start-up capital they signed up 14 New York restaurants,
charging them 7 percent of the tab, and initially gave cards away to people.
23
(The observant
reader will note that for must of us owning a credit card would not help our predicament
when we leave our wallets at home. The proverbial apple falling on the head is a mysterious
force.)
By its first anniversary there were 42,000 cardholders who were each paying $18 year for
membership in the club. There were 330 U.S. restaurants, hotels and nightclubs that
accepted these cards; they paid an average of 7 percent of the cardholders bill to Diners
Club. In March 1951, Diners Club handled about $3 million of exchanges between
cardholders and merchants (it reportedly made almost $60,000 in profit before taxes).
24
In
1951 Frank McNamara, founder of Diners Club, predicted that monthly transaction volume
would increase to about $7 million by the end of the year.
25
Diners Club was therefore getting
more than three quarters of its revenues from merchants.
26
Moreover, the margin on
cardholders was low since they were getting free float for an average of two weeks.
By 1958, it had raised the cardholder fee to about $26 but left the merchant fee at 7
percent. Nevertheless, it continued to earn most of its revenues, about 70 percent, from
merchants.
27
The same year saw the birth of two of the major competitors to Diners Club.
American Express, which had long been in the travel and entertainment business with its
travelers checks and travel offices, decided to enter the industry. It recognized need to get

21
Dining on the Cuff (1951) Newsweek, January 29.
22
Except where noted, all dollar figures in this paper have been adjusted to constant 2002 dollars.
23
See Mandell (1990) and Grossman (1987).
24
Charge It, Please (1951) Time, April 9.
25
Dining on the Cuff (1951) Newsweek, January 29.
26
Cardholder fees totaled about $745,000 while merchant fees totaled about $2.5 million.
27
On-the-Cuff Travel Speeds Up (1958) Business Week, August 16.
Review of Network Economics Vol.2, Issue 3 September 2003
202
both sides on board. Even before the first transaction, it had already acquired a cardholder
base of 150,000 from the American Hotel Associations card program, as well as the
programs 4,500 hotels for its merchant base. It bought another 40,000 cardholders from
Gourmet magazines dining card program (Grossman, 1987). It soon had a cardholder base to
sell to T&E merchants, and sent out representative to sign them up. It also advertised in
newspapers for additional cardholders (Grossman, 1987). American Expresss positive
reputation in the T&E industry was also a benefit in attracting both sides of the business
(Grossman, 1987). By the time of its entry on October 1958, it already had 17,500 merchant
locations and 250,000 cardholders (Grossman, 1987).
American Express adopted a slightly different pricing policy than Diners Club. It initially
set its annual fee at $31, $5 higher than Diners Club, thereby suggesting that it was the more
exclusive card (Friedman and Meehan, 1992). But it set the initial merchant discount
slightly lower: 5 to 7 percent for restaurants; and 3 to 5 percent for the recalcitrant hotel
industry.
28
Within a year, its cardholder base had grown to 700,000 and its merchant base to
37,000.
29
With its slightly higher cardholder fee and slightly lower merchant fee, American
Express received just under 55 percent of its revenue from merchants, compared to over 65
percent for Diners Club in 1959.
30
This would grow over time, however, as spending per card
increased faster than annual fees.
American Express had been successful getting both sides on board but initially struggled
to make a profit. It responded by putting more pressure on cardholders to pay promptly. It
also managed to raise cardholder fees without suffering significant attrition. There were
900,000 cardholders that could use their cards at 82,000 merchant locations by the end of
1962, the first year that the card operation posted a small profit (Hammer, 1962).
The other significant entrant in 1958 was Bank of America (this card evolved into Visa).
Unlike many other banks, it had always focused on lending money to the middle class. By
1958, Bank of America had extensive experience in making small loans on consumer
durables such as refrigerators and automobiles. It had also become the largest bank in the
country (Mandell, 1990).
One of its small competitors, the First National Bank of San Jose, started a charge card in
1953. At the time, Bank of America considered introducing its own card but decided that
there was not a good enough business case. After studying the emerging industry over the
next few years they decided to introduce a credit card. Credit-worthy customers would
receive cards with limits of either $1,600 or $2,600; prior authorization would be required for
purchases over $130; and a revolving credit option was available for some cardholders
(Wolters, 2000). Revolving credit was the feature that distinguished this card from existing
charge cards. The merchant fee was initially set at 5 percent and lowered soon thereafter
(Wolters, 2000). Cardholders did not pay an annual fee but paid finance charges on any
revolved balances at an annual interest rate of 18 percent (Wolters, 2000). This was a more
merchant-friendly balance than that set by Diners Club or American Express, especially
considering that Bank of Americas card was also extending credit on a revolving basis.
Bank of America did a market test in Fresno in the fall of 1958. Three hundred retailers
signed up initially, and every Bank of America customer in the Fresno area received a card.
According to one study, This mass mailing of 60,000 cards had been Williams (the Bank of
America leader of the effort) solution to the problem of how to convince retailers that enough
individuals would possess a card to make their participation in the program worthwhile. His

28
On-the-Cuff Travel Speeds Up (1958) Business Week, August 16.
29
Towards an Ever-Fuller Life on Credit Cards (1959) Newsweek, September 28.
30
Figures taken from Newsweek 1959 article, and assuming average of 5 percent for Amex per Newsweek 1958
article.
Review of Network Economics Vol.2, Issue 3 September 2003
203
solution worked, for during the next five months another eight hundred Fresno-area retailers
joined the newly named BankAmericard program (Wolters, 2000). They expanded
throughout the state during the following year. By the end of 1959, 25,000 merchants
accepted the card and almost two million California households had one.
Things did not go well. Fraud was rampant. The number of delinquent accounts was five
times higher than expected. Large retailers resisted joining. The program lost $45 million in
1960. The bank worked on collection problems and lowered the merchant fee to as low as
three percent to entice retailers. Delinquencies declined and the merchant base increased to
35,000 in 1962. It was profitable by the early to mid 1960s.
One notable common theme across the experiences of the three startups is the importance
of getting both sides on board. Diners Club, starting from scratch and trying to sell a new
product, had to build slowly. It set a relatively cardholder-friendly balance, collecting most of
its revenues from merchants. This made it possible to sign up cardholders even before a
significant merchant base had been signed. The cardholder base could then be used, of
course, to sign up merchants. By the time of American Expresss entry, the idea of a charge
card had already been established by Diners Club and others. American Express was able to
capitalize on that by entering at a larger scale. Indeed, it probably did not have the option of
entering as gradually as Diners Club did, since what cardholders or merchants would sign up
with a fledgling American Express card given the option of an established alternative.
American Express therefore bought up customer bases on both sides before it entered. It was
also able to use its established position in the T&E business to set a slightly higher
cardholder fee, to cultivate the upscale image that served it well for a long time.
Bank of America also developed a large cardholder base in entering the business. It used
its base of depository customers, the largest in California, to develop an instant cardholder
base, which it then used to sign up merchants. Even with its prominent position among
consumers in California, however, Bank of America had to strike a more merchant-friendly
balance, lowering its merchant fees until it could get enough merchants on board.
Perhaps as a consequence of entering at a larger scale, both American Express and Bank
of America, unlike Diners Club, had a hard time making a profit early on. Diners Club made
a profit in its first year, while the other two firms did not see a profit until their fourth or fifth
years. It took time to weed out delinquent cardholders. Having to make an upfront investment
in building a profitable cardholder base is a lesson that holds even for new card issuers today
(although they can join Visa or MasterCard and do not have to build an entire system). There
were also the operational problems that would be expected in starting up any new business.
Bank of America had such (misplaced) confidence its customers would pay their bills that it
did not even set up a collections department (Nocera, 1994).
5 The Palm OS and community-building in software platforms
Palm was founded in 1992 as an effort to develop software applications for personal digital
assistants (PDAs). In 1993, Palm released the Zoomer in collaboration with five other
companies Casio, GeoWorks, Tandy, Intuit, and America Online. Palm was responsible for
the application development while the other five companies handled the hardware, the
operating system, and distribution. The Zoomer, with its high price ($820) and poor
handwriting recognition, ultimately failed with only 15,000 units sold (Gawer and
Cusumano, 2002). Zoomer was not the first failure. Apple had made the first attempt with its
Apple Newton in 1993. Other entrants into the PDA market from 1993 to 1996 were the
Psion Series 3, Hewlett-Packard LX, Hewlett-Packard OmniGo, Sharp Zaurus, Sharp Wizard,
Review of Network Economics Vol.2, Issue 3 September 2003
204
and Microsofts Windows CE
31
PDAs. With the exception of the Windows CE PDA, all
followed an integrated strategy where the PDA manufacturer produced the hardware,
operating system, and applications. Windows CE PDAs had a non-integrated strategy, where
the hardware, operating system, applications were all developed by different firms (although
Microsoft did end up writing the operating system as well as many applications for Windows
CE). The integration of application and operating system development within one firm was
common in the software industry, for example Microsoft produced some of the most popular
applications for the Windows OS (Evans, 2003).
Palm re-entered the handheld market in 1996 with the Palm Pilot. This integrated
hardware, an operating system, and some applications. Palm overcame the handwriting
recognition hurdle with the invention the Graffiti text entry method, providing users a simple
method to enter text. Industry experts described Graffiti as the killer app for the Palm Pilot
(Feldstein and Flanagan, 2001). The pricing of the Palm Pilot also reflected Palms desire to
have deep market penetration. While 3Com, Palms parent company from June 1997 to
March 2000, wanted Palm to price the Palm Pilot high to extract profits, Palm insisted that
prices be kept low to expand the user base (Gawer and Cusumano, 2002). The Palm Pilots
combination of low price and robust features were a hit with consumers and provided the
most bang for the buck (Atluru and Wasserstein, 1998). The Palm Pilot met immediate
success with over 360,000 units sold in 1996, representing 51 percent share of the market
(Atluru and Wasserstein, 1998).
32

Palm has gone through three stages in developing what is now a three-sided platform
business. In the first phase from about 1996 to 1998, it entered as an integrated platform. It
made the hardware, operating system, and applications for the Palm Pilot and integrated them
together. It planned to court developers, however, only after it had a significant user base.
According to Donna Dubinsky, CEO and one of its founders, We are a highly integrated
product that delivers end user results. We are not having a developer conference until we sell
a million units (Atluru and Wasserstein, 1998). A developer conference is one of the major
methods used by software platforms to stimulate the writing of applications. Nevertheless,
even during this initial phase Palm laid the groundwork for getting a developer community
on board.
33
In early 1996, Palm released its first software development kit (SDK), which
included the source code for the Palm Pilots bundled applications. This source code served
as a model that outside developers could reference to build other applications (Gawer and
Cusumano, 2002).
In 1998, Palm sold over 2 million PDAs and launched the second phase of market
development. Palm invested resources in persuading developers to write applications for the
Palm OS. It offered business development resources to developers, including joint
development, marketing, and bundling. Palms most important business development
resource was its software development forums (SDF), which helped external developers start
and grow their own businesses. The SDF offered advisory meetings, business seminars,
workshops, and networking events. It also started a $54 million venture capital unit called
Palm Ventures to support businesses focusing on Palm OS applications. The company also
offered Palm OS development classes regularly, and encouraged other activities among its
community of users through developer portals (Gawer and Cusumano, 2002). The strategy to
actively get developers on board was successful. The number of registered developers grew

31
Windows CE was renamed Pocket PC at version 6.0.
32
This represents market share of Palm hardware PDA and does not include licensed Palm OS devices.
33
In fact, in the first year of release, the Palm attracted over 2,000 third-party developers to its platform without
any developer support efforts (Atluru and Wasserstein, 1998).
Review of Network Economics Vol.2, Issue 3 September 2003
205
from 7,500 in 1998 to 220,000 in 2002.
34
Palm continued to secure its market leadership,
with over 7 million units shipped by 2000.
The third phase, from about 2001 to the present, has moved Palm closer to being a pure
operating system company. Palm has created alliances with Sony, Nokia, Handspring, IBM,
Qualcomm, Supra, Symbol Technologies, Fossil
35
, and TRG Products to create PDAs and
other computer appliances based on the Palm OS (Gawer and Cusumano, 2002). Palm has
reported that this greatly increases the market share of Palm OS based PDAs over their
potential market share with an integrated strategy.
36
In addition, Palm OS licensing has
expanded the scope of the Palm OS beyond traditional PDAs to such devices as wrist watches
(Fossil Wrist PDA), cellular phones (Handspring Treo), and multimedia players (Sony Cli).
While Palm manufactured PDAs claimed 50 percent of the market in 2000, devices powered
by the Palm OS operating system had over 75 percent share of the worldwide personal
companion device market according to a report by International Data Corporation.
37
This
market share increased to over 82 percent by the second half of 2002.
38
In January 2002 as
Palm powered devices hit 20 million sold, Palm formed a Palm OS platform subsidiary,
PalmSource, further separating the Palm OS from Palms hardware solutions.
39

Palm claims that its operating system was designed from the start to provide a platform
for these three sides. According to Palms web site,
From the start, the flexible, extensible Palm OS has been designed to grow and evolve in
response to user needs. The open, modular architecture allows our more than 50,000
developers, licensees, alliance, and OEM partners to develop innovative new products and
applications for a rapidly expanding global market (Gawer and Cusumano, 2002).
Palm has subsidized both the application developer side of the market and the user side of
the market by licensing their operating system at a loss and giving their development tools
away for free. It is able to do this because of its profits in hardware sales. Palm provides an
SDK, Palm OS Emulator, Palm OS Simulator, and sample source code free for download on
its web site. Palm also provides links to third-party integrated development environments,
both free and not, for download on their web site.
40
Palm also offers an online developer
support program to offer a full range of development services. The Basic Level Membership
is offered at no cost. The Advanced Level Membership is available for just $500 per year and
includes direct technical, marketing and training support.
41
Only a small percentage of Palms
revenues were from licensing of the Palm OS. PalmSource revenues totaled $67, $88, and
$50 million, while operating loss totaled $17, $8, and $8 million in fiscal years 2002, 2001
and 2000, respectively.
42
This continued loss of PalmSource represents Palms continued
efforts in trying to expand the user base of the Palm platform.

34
Palm, Inc. (1998) Key Strategic Relationships And Growth To 7,500 Developers Propel 3Com Palm
Computing Platform Into Corporate America, June 15, http://www.palm.com/pr/enterprise.html; Palm, Inc.
(2002) Annual Report.
35
Palm, Inc. (2002) Fossil Signs License Agreement with PalmSource For First Ever Palm Powered Wrist
Devices, November 18, http://www.palmsource.com/press/2002/111802.html.
36
Palm, Inc. (2001) Annual Report.
38
Palm, Inc. (2003) Palm Powered Share Increases in Second Half of 2002, January 27,
http://www.palmsource.com/press/2003/012703.html.
39
Palm, Inc. (2002) Palm Completes Formation of Palm OS Subsidiary as Palm Powered Devices Hit 20
Million Sold, January 21, http://www.palmsource.com/press/2002/012102.html.
40
Palm, Inc. (2003) PalmOS: Desktop Development, http://www.palmos.com/dev/tools.
41
Palm, Inc. (2003) PalmOS.com: Palm OS Developer Program, http://www.palmos.com/dev/programs/pdp.
42
Palm, Inc. (2002) Annual Report.
Review of Network Economics Vol.2, Issue 3 September 2003
206
6 Summary
Multi-sided platform markets are becoming an increasingly important part of the economy.
They range from relatively small emerging companies like eBay, Yahoo!, and Palm, to
relatively large and mature companies like American Express. These markets also have had a
large impact on the recent information technology boom, and undoubtedly, they will continue
to be important, as internet based commerce expands its scope to include both new and old
economy firms. In addition to internet commerce, other increasingly important industries,
such as credit cards, operating systems, shopping centers, and mass media, are all governed
by the economics of multi-sided platforms.
While it is not my intention to generalize from a small sample, and many issues need to
be investigated in more depth, a number of business models appear common across both the
cases studied here. First, differential pricing is used to get both sides on board. Second, once
both sides are on board, pricing continues to play a key role in maintaining both sides of the
platform. Third, multihoming often occurs in multi-sided platforms. And, fourth, one solution
to the pricing complexity that has been used successfully is to start with a small but scalable
platform.
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